RESPONSIBLE LEADERSHIP

Getting the right results the right way

By Dr John R. Wells - November 2009

The recent turmoil in financial markets is ascribed by many to be a failure of leadership and the calls for more responsible leadership continue to grow. But what is responsible leadership? There is a danger in taking too narrow a view and simply bowing to critics demanding more corporate social responsibility. Responsible leadership is more than this; it is a balance of between getting the right results and getting results the right way.

Getting the right resultsThe goal of any enterprise is to deliver superior sustainable performance.

“Performance” is a measure of the value created per unit of resources consumed. For companies, we might look at return on investment; for a charity like Operation Smile[i], the number of hair lip operations done for every dollar donated.

“Sustainable” means over the long term rather than to meet the next quarterly earnings targets. A firm might do well to remember that, unlike its employees, it could live forever and should encourage its managers to make decisions that reflect this long term view.

“Superior” means better performance than others competing for the same resources. Success attracts more resources and therefore provides greater sustainability. It also generates a greater surplus to share amongst the many stakeholders who feel they are entitled to a return. Society benefits because it is the more profitable companies who can afford to be socially responsible; and in a resource-constrained world, is it not our moral responsibility to deliver greater value from limited resources?[1]

What does it take for an enterprise to deliver superior, sustainable performance? The foundation is always a good strategy - the integration of choices about where and how to compete. Successful enterprises focus on where they can create the most value and rely on outside suppliers for anything else. Second, it takes good execution and the integration of actions to deliver on the strategy. Both of these require good leadership to ensure that the right choices are made and the actions are taken.

But many enterprises with solid strategies and execution still fail eventually because, in a changing world, they fail to adapt. They are felled by inertia, a most fatal disease. As Jack Welch pointed out, “I'm convinced that if the rate change inside the institution is less than the rate of change outside, the end is in sight. The only question is the timing of the end.” Responsible leadership demands agile strategy and an agile structure to support it. But the capacity of an organization to change is ultimately limited by the willingness and commitment of the people in the organization to change. Responsible leadership requires encouraging agile minds and attitudes.

Getting results the right wayMany enterprises, when evaluating their people, have come to the view that delivering results is not enough; how you deliver them has a profound effect on the long term health of the enterprise. Companies must respect the simple principles of fairness and honesty, and encourage a long and broad view.

Be fair, build trustThe rather simplistic, traditional capitalist view of a firm is that its purpose is to maximize shareholder returns and minimize the cost of “constraints” such as customers, employees, suppliers and regulators.

The danger of delivering the absolute minimum is clear. Customers will switch to another provider as soon as they find better value. Instead, firms aim for a more loyal, stable customer base by “delighting” customers through offering them more than they expected for their money. Regarding employees, paying them a pittance does not create loyalty and commitment; and with suppliers, aggressive purchasing techniques to drive prices down to a minimum are increasingly being discredited. Why should suppliers share their latest ideas on product design or cost reduction with customers who bully them?

Minimizing cost constraints may make economic sense in a one-off negotiation, but business, like life, is a multi-round game, where relationships of trust are crucial. If trust fails, transactions don’t take place; just look at what has happened in the financial securities markets.

In practice, few companies really operate on this model. Most executives prefer to pay more than the minimum to the “constraints” since this creates trust and loyalty, drives more innovation and creates more options for the future.

Be honest - Don’t steal assets from the balance sheetA core value in delivering results the right way is honesty, but some firms discourage this by presenting their employees with moral hazards. Consider the plant manager who gets promoted for achieving greater profitability by deferring important equipment maintenance. This is tantamount to “stealing” from the physical asset base. Firms must ensure that assets are handed to the next generation in the same excellent condition as they were originally.

The same holds for human assets. In professional service firms, there are those managers who exploit young professionals, working them to exhaustion and doing little to develop them. This is stealing from the asset base and from the firm’s future.

Brand assets may be devalued by breaking the promise that the brand implies. One example is an insurance company that improved its profitability (for a time) by not paying claims.

There is also stealing from the financial balance sheet. CFOs have a great deal of discretion over how profit is defined, so they can hide profits in the balance sheet in good years and scrape profits from the balance sheet in the bad years. This is called earnings smoothing. It all starts to go wrong when earnings collapse and suddenly there are no assets left to scrape. Painful changes follow, which might have been avoided had its executives practiced more responsible reporting.

The challenge for firms is to create incentive systems which discourage members of the firm from stealing from the asset base. It is less of a problem in firms where executives spend entire careers, since they are more likely to be “found out”. This is also true of family businesses where the stigma of “stealing from family” is high. However, in a world where CEO and employee tenures have shortened dramatically, the moral hazard is clear. It is imperative that we instill these values and closely monitor them.

Take a broad, long viewThe benefits of honesty and fairness become more apparent when taking a long, broad view of performance. We are part of a complex, dynamic system. We would do well to reflect on how our current decisions might affect performance, both today and tomorrow. The reality is that firms have many stakeholders, and it is dangerous to consider any of them as costs to be minimized. We are in this for the long run.

Corporate social responsibility
Corporate social responsibility had just a brief mention at the beginning, but this is not to say that it is not an important part of responsible leadership. The concern for social responsibility is probably best channeled by enlightened self interest – the pursuit of superior sustainable performance.

Firms can make high returns while showing concern for society. Whole Foods offers a wide range of sustainably-produced products, a great shopping experience for its customers and an excellent work environment for its employees while also providing high shareholder returns. Patagonia is equally successful in outdoor clothing. There are a myriad of companies generating profits from renewable energy and water purification. Other companies have discovered the benefits of serving the bottom of the pyramid while improving the lives of the poor. These are all examples of enlightened self-interest. Whenever there is value to be created from solving a problem, the efficiency of private enterprise is a fast and effective way of realizing that value.

So I would encourage firms to be concerned in profitable ways.

Responsible leadership at the national levelNations, too, should strive for superior sustainable performance while being fair and honest with other nations, taking a broader, global, long term view. A regulatory environment that encourages enterprises to seek superior, sustainable performance is a must. The nation state by itself cannot effectively regulate huge global corporations, which are larger than many small countries and reside in many corners of the world. Equally important is that nations provide the necessary infrastructure to support competitive enterprises. Superior national performance comes largely through superior enterprise performance.

Trade policy that focuses the nation on doing what it is best at and relying on other nations to focus on their comparative advantages is also key. Responsible nations should invest in competitiveness, not protectionism. By doing so, they will ensure a fairer distribution of global wealth, more inclusive growth and less chance of conflict driven through inequity. And with the democratization of information via the internet, populations are watching and increasingly demanding fairness.

Each nation cannot, alone, deal with the challenges this planet faces over the next 50 years. The sooner our species wakes up to this, the more we increase the chances we will survive into the next millennium.

Dr John R. Wells is the President of IMD.

[1] Profitable firms have the luxury of being more socially responsible; social responsibility by itself does not automatically generate superior profits.